Activist Investors Find Allies in Mutual, Pension Funds

Institutional investors, who used to shun activist investors and side with a company's management on most controversial issues, are starting to change their tune.

Aggressive shareholders such as Carl Icahn and Bill Ackman, who agitate for change at companies they believe to be sub-par, are increasingly getting a hearing with institutions ranging from the most staid mutual fund to the state-run pension fund.

Philip Larrieu, an investment officer at the California State Teachers Retirement System (CalSTRS), said activist investors have won more respect as their research has improved and their campaigns succeeded.

"There are some that are very aggressive and people don't like them because they are so aggressive, but then it turns out they might have a point," Larrieu said in an interview, declining to give specifics.

Last November, CalSTRS teamed up with Ralph Whitworth's Relational Investors to urge for a breakup of diversified manufacturer Timken Co., the first time the California pension plan has participated in this kind of activism.

In February, T. Rowe Price Group opposed a $24 billion buyout bid for Dell, one of only a handful of times in the past decade that the Baltimore-based money manager has publicly rejected a financial strategy endorsed by management.

Activist investors, proxy advisers, and fund managers say institutional support has emboldened some corporate gadflies to take on more and larger companies than they would have in the past—to the extent that even the likes of Apple and Procter & Gamble have come under attack.

There were 241 activist campaigns in 2012 targeting a change in company strategy or board, up from 187 in 2009, according to FactSet SharkWatch. More than 20 percent of the campaigns last year targeted companies with at least $1 billion in market value, up from 7 percent in 2009.

Data on institutional support for shareholder activism is hard to come by, but mutual fund managers say their interest is driven in part by the performance that activists have demonstrated in recent years. Increased focus on corporate governance is another driving factor.

Dimensional Fund Advisors, the eighth largest U.S. mutual fund company with $262 billion in assets at the end of 2012, said it rarely engaged with activists before 2007, but formed a corporate governance group that year and started meeting with activist investors a few years ago.

"We felt that we should be more proactive in gathering information and being informed so we could vote our proxies better," said Joseph Chi, co-head of portfolio management at the Austin, Texas-based DFA. "As a very large shareholder in companies that are engaged in proxy contests, this is a good opportunity to have our voice heard."

Pressure to Perform

Activist investors focus on companies they believe can provide better shareholder returns through a change in strategy or management. With the U.S. economy in recovery mode, shareholders are putting more pressure on underperformers—especially companies with cash on the balance sheet that investors think can be put to better use, such as at Apple.

"Three or four years ago everyone was in crisis and everyone had to be conservative and preserve cash but now you can see which companies aren't recovering," said Donna Anderson, a corporate governance specialist at T. Rowe Price. "I think more investors have been successful with achieving their objectives, whether it is to get a board seat or ultimately to lay out M&A."

The financial crisis also jolted some passive investors into placing more emphasis on corporate governance.

"The climate has changed and people are very focused on changing corporate conduct or more broadly around financial performance. If you are an activist hedge fund, you have the wind at your back," said Chris Cernich, executive director of mergers and acquisitions and proxy contest research at influential proxy advisor ISS. "I think the financial crisis has contributed to this climate and I think it's here to stay."

Relational's Whitworth, who pressured industrial conglomerate ITT Corp. to break up and last week was named interim chairman of Hewlett-Packard, said institutional investors have evolved from "accepting" to "inviting" shareholder activism.

"We do get a lot of calls from institutional investors," Whitworth said. "Institutional investors see the activity as beneficial and they're much more likely to be supportive."

To be sure, some fund managers and index funds remain wary of engaging too closely with activist investors.

"Our question is what is the long-term case. We are going to be permanent holders of the stock and it is not in our interest to support an initiative that will result in a short-term pop in stock price that isn't sustainable," said Glenn Booraem, controller of funds at the Vanguard Group.

Capital Inflows

U.S. mutual funds and public pension plans together own 42 percent of all U.S. stocks, according to Bogle Financial Markets Research Center. Their willingness to listen to activist investors has emboldened some activists to buy stakes as small as 1 percent in their targets, and seek support to drive change.

"More activists are spending more time with shareholders and research analysts, and they are spending less time with the company," said one industry banker, who wished to remain anonymous because he is not allowed to speak to the media.

Over the past three years, activist hedge funds have outperformed more traditional hedge funds, according to Chicago-based Hedge Fund Research. Its activist index has returned 3.80 percent on an annualized basis, compared to its global hedge fund index, which has returned only 0.25 percent.

That has drawn the attention of investors. Activist funds' assets under management doubled to more than $65 billion in 2012, from $32 billion in 2008, according to HFR.

"Activism is a new asset class that people track," said Chris Young, head of contested situations at Credit Suisse Group. "Right now the view from pension funds is that we can get outsized returns."

Last year, hedge fund TPG-Axon Capital urged oil and gas company SandRidge Energy to consider selling itself and asked Chief Executive Tom Ward to step down, marking only the second time the New York-based fund has filed an activist proposal.

In March, TPG struck a deal with SandRidge that placed four of the hedge fund's nominees on the board.

"You've got funds that were not activists but that have been increasingly willing to use that tool," Young said. "It is like a Pandora's box, once you opened it and used that tool, you realize you can use the tool again."